China Slowdown Less Crash, More Cool Calculation

Slowing metrics, plunging stock values don’t tell the whole story

Investors don’t have much of an appetite for China these days. The iShares FTSE/Xinhua China 25 Index (NYSE:FXI) — an ETF that acts as a benchmark measure of China’s biggest stocks — has plunged about 13% during the past five trading sessions. Waning metrics in the Chinese economy, along with a general sense of fear that we could be on the precipice of another global recession, can be blamed for much of the capital flight away from Chinese equities.

One metric clearly headed lower is HSBC’s China Manufacturing Purchasing Managers’ Index, also known as the “flash” PMI. The measure dropped to a two-month low in September to a reading of 49.2, which is down from 50.2 in August. Any reading below the 50 level is considered a sign of contraction in industrial output. The widely watched number also suggests a wider slowdown in the Chinese economy.

While the weaker Chinese manufacturing numbers do indeed signal a contraction in the country’s economy, it helps to put this contraction in context with the wider economic picture in China.

First off, the HSBC “flash” PMI data confirming the economic cooling taking place in China actually is commensurate with the goal of policymakers in Beijing. Officials who turn the dials on the Chinese economy have repeatedly increased bank reserve requirements this year — all in an effort to keep lending from getting out of control, and to keep a lid on rising real estate prices and the more pernicious food inflation. To a large extent, China has succeeded in this effort, and the evidence, in part, is the contraction in industrial output.

Ironically, what we’re seeing in China is almost the polar opposite of what’s going on the U.S., as the Federal Reserve is trying to keep interest rates low to stimulate economic growth. It’s also attempting to “twist” the maturities on bond holdings to facilitate more lending and more home buying.

The fact is that even with a slowdown, the Chinese economy is light-years away from a crash. Just look at the recent GDP growth estimates from the International Monetary Fund, which have the Chinese economy “slowing” to 9.5% growth in 2011. Yes, that figure is less than the 10.3% growth we saw in 2010; however, even the slower growth still accounts for more than 30% of the world’s total GDP. Yes, China is slowing down, but not nearly enough to cause a so-called “hard landing” or GDP growth below 8%.

For investors with an intrepid sense of adventure and the stomach for a lot of volatility, getting in on Chinese stocks now could pay off big time in the months to come. The iShares FTSE/Xinhua China 25 Index hasn’t traded at current levels since April 2009, and that means you can buy China’s growth at a discount price.

At the time of publication, Jim Woods held no positions in any of the stocks mentioned in this article.